Clearly the bloom is off the rose. During the first three months of this year India’s economy grew 5.3 per cent, the slowest rate in almost a decade and sharply down from 9 per cent last year. Both the agriculture and manufacturing sectors have been hit by slowdowns while industrial output actually contracted. Inflation hovers over 7 per cent and the rupee has sunk to record lows against the dollar.
Foreigners continue to invest in India, but net financial flows have slowed and will likley decline further if the economy continues to struggle. Foreign and domestic investors alike are deterred by proposed tax changes, regulatory uncertainty and increasing tension between corporate India and the government. The resulting fall-off in business investment is a major contributor to the current malaise.
India suffers from three deficits: fiscal, current account and governance. The budget deficit has widened, bloated by costly subsidies and generous welfare schemes while proposed tax reforms that would raise revenues are stalled. Standard & Poor has warned that India could lose its investment grade rating and be downgraded to junk category if the situation doesn’t improve.
The current account is also worsening. Although exports have grown this past year, it has not been enough to offset costly imports of energy and other commodities. A weaker rupee may help exports, but the eurozone crisis will not. A large trade deficit combined with slowing capital inflows is expected to push the current account deficit above 4 per cent of GDP this year.
The biggest worry is a deficit in governance. Within the Congress Party-led coalition there are divisions inside the Party itself and between coalition members. The reformist instincts of Prime Minister Singh have been thwarted by the populist leanings of Congress Party President Sonia Gandhi and by regional partners such as Mamata Bannerjee in West Bengal. Weakness at the centre has emboldened other states to flaunt their powers in areas affecting their interests.
A series of high-profile scandals has implicated several ministers and further debilitated the government. Decision-making has ground to a halt as ministers look over their shoulders, fearful of intense public scrutiny and a zealous media. For the same reason large corporate groups, even those with reputedly close links to government, have been unable to secure approvals for major investment projects.
On the rare occasion that a new policy is announced, it is often quickly reversed in the face of heated opposition. A prominent and potentially damaging example is the retroactive tax on foreign investors introduced ostensibly to nullify the impact of a Supreme Court judgement in favour of Vodafone. Such flip flops and the absence of needed reforms undermine business confidence, discourage investment and constrain growth.
Has India’s bubble burst? Hopefully yes in the positive sense that inflated projections of future growth will be replaced by more realistic expectations. Very few major economies have enjoyed continuous, straight-line growth. This is especially true for democracies whose leaders are subject to re-election and usually eschew unpalatable economic reforms. India is the world’s largest democracy and arguably the most rambunctious.
Yet, despite the economic malaise and current political paralysis, India’s long term prospects are undiminished.
The fundamentals that have underpinned over 7 percent average growth during the past decade are still intact. For an economy roughly the size of Canada’s, 6.5 percent growth expected this year isn’t shabby.
Democracy is one of India’s greatest strengths. For a country of India’s size and diversity, it is the only feasible system of government. Indian democracy is slow moving and uneven, but it expresses the popular will and therefore mitigates political risk. To paraphrase Churchill, “it may not be perfect, but it is the best system available”.
India is also the world’s largest federation. Its 29 states have considerable autonomy in economic matters which explains why some are more business friendly, and consequently faster growing, than others. This disparity together with an increasing willingness to vote across caste and religious lines has resulted in the ouster of some non-performing state administrations and improved the performance of others. Formerly backward states such as Bihar and Orissa now exceed the national growth rate.
India is the second most populous country in the world with a median age of 26. Its young, ambitious and enterprising workforce has the potential to generate enough savings and investment to propel the country to among the top three global economies by 2030, but only if a new wave of reforms provides them with the necessary skills and opportunities.
By 2025, another 130 million Indians will migrate to the cities. This will generate a surge in infrastructure building ($1 trillion over the next five years); boost productivity as workers leave the less productive rural sector; and foster social integration in urban melting pots.
Within the next decade, India’s rapidly growing middle class will exceed 500 million people. The resulting jump in discretionary spending, along with changing tastes and consumption patterns, will drive the economy and buffer it from the external shocks to which most other emerging markets are prone. By some estimates, India will account for the largest share of global consumption by 2030.
The “bottom of the pyramid” will not be left behind. The rural-urban income gap continues to decline. Rural India now accounts for close to half of GDP and will continues to spur innovative, low-income products such as the Tata Nano city car, that can be sold in large volume locally and later adapted for sale globally.
For these reasons projections that India will rank among the top three global economies are still credible. It may take longer than some people predicted, but it will happen. India should not be measured merely in terms of short-term growth. It is a long-term value investment, subject to ups and downs, but ultimately rewarding for committed and patient investors.
Peter Sutherland is the Vice-Chairman of the Canada-India Business Council and Senior Business Advisor, Asia, Aird & Berlis LLP. He was previously Canada’s High Commissioner to India as well as Ambassador to Saudi Arabia and the Philippines.